The Ultimate Guide to 1031 Exchanges: Tips from Real Estate Expert James Bean

Kristen Knapp (01:31)

Welcome back to the Real Estate Pros podcast. I’m Kristen Knapp and I’m here with James Bean, real estate investor serving the Los Angeles area and an expert in the 1031 exchange, which I’m so excited to get into. Thank you for being here today. Yes. So let’s just hop right into it. You’re very knowledgeable about the 1031 and the different types of ways that you can benefit from it and understand it. So I would love for you to just kind of…

1031 Broker James (01:44)

Thank you, Kris.

Kristen Knapp (01:59)

briefly get into how this became such an interest for you.

1031 Broker James (02:04)

Yes, well, you know, was back in 2018, I really started focusing on 1031 exchanges because I recognized the niche that really wasn’t being served. And that was having a broker that represents some of the, well, our senior citizens, if you will, our elders that are

65, 70 years old that have held on to their assets, in most cases, probably too long, and recognize that there really wasn’t any brokers that were really specializing in representing exchange buyers. So ⁓ to back up a little bit from that, I was recruited by Marcus and Milocha to open a new office here in Ventura, California, back in 2014. And

In that experience, I really got a bird’s eye view on the net lease world and didn’t really have much experience around that. And so I recognized that, know, net lease assets are a great option for exchangers because you can, you know, in the absolute net lease world,

These assets are held by corporate tenants, corporate guarantee, strong credit rating tenants, long-term. If you can find brand new construction with 15, 20 years of term, just really a nice hands-off passive investment for this investor class. so in 2018, I was asked to do a presentation on 1031 exchanges and I decided I was going to do an

presentation on the myths of the 1031 exchange. Well, in my research, I found more than 45 myths online, 45 different myths around the exchange. And also during this time is when I realized and found out that more than 60 % of exchanges fail every year. And that was just a boggling, mind boggling number to me. And that’s kind of when I decided

Kristen Knapp (04:08)

Wow.

1031 Broker James (04:29)

really focusing on becoming more of a resource. I was fortunate that I had investor clients early in my career that I was able to.

represent them in 1031 exchanges. And that was something that, you know, over time learned a lot about the 1031 exchange. And now here we are seven years beyond 2018. It’s where now I have the website and the YouTube channel to really be a resource, not just for the investors, but also for real estate agents.

Kristen Knapp (05:04)

I love that, that’s so awesome. And then tell me more about these myths. We don’t have to get into all 40 plus of them, but what are some of the biggest that you see?

1031 Broker James (05:14)

Yeah, well, probably the most common is how the 1031 exchange is named. And the tax code is known as the tax-affirmed like-kind exchange. And the words like-kind really confuse a lot of people, mostly the senior citizen, people that are 65 and older.

They’ve owned their assets for a long time.

It’s not a week goes by where I talk to somebody that says, you know, my grandparents or my aunt and uncle or somebody, they own a duplex or they own a fourplex and they want to sell it. And they’re going to they know they’re going to get nailed in capital gains tax, but they really don’t want to exchange because they don’t want to have to.

exchange or buy another fourplex because they think they have to exchange into a like kind. So I think that’s probably one of the most common myths. ⁓

Another one. Go ahead. ⁓

Kristen Knapp (07:10)

And so they don’t have to buy into

a like kind of building or whatever. Explain more about that. I would love to hear more about that.

1031 Broker James (07:21)

Yeah, so the way that they, the IRS looks at it is that like-kind meaning as long as it’s investment property for investment property. You know, the code actually says properties that are held for investment, business or trade. And so meaning really that you can’t use the exchange for anything that you use for personal use. So it can’t be your home.

It can’t be your vacation home. can’t be any of those things. It has to be property that’s held for investment, business, or trade.

So as long as, if you’ve owned, even if it’s a single family home rental, which a lot of people own those, you can sell those and exchange into commercial property. You can exchange into, you know, a farm that has income from the crops. You can, a gas station, what a, anything that, excuse me, anything that is, ⁓ again, health or investment, trade or business, you can exchange into.

Kristen Knapp (08:33)

That’s really good to know. think a lot of people probably don’t know that.

1031 Broker James (08:38)

It’s alarming how many people don’t realize that.

Kristen Knapp (08:41)

Yeah. And when you say that more than 60 % of exchanges fail every year, that’s a crazy number. What is the biggest reason that you see?

1031 Broker James (08:53)

You know, I wish I had a solid answer for that. The one thing I can tell you is that the common denominator is lack of planning. People just don’t plan how their exchange should go. And so the number one piece of advice that I give to all real estate investors is that if you have an investment property that you want to dispose of, you should be mapping out and planning your exchange before you even put

that property on the market that you want to sell. You should know what you’re going to exchange into. You should know what your options are because you know, once you put it on the market and the property gets into escrow and ultimately closes, you’ve only got 45 days to identify that replacement property. And I don’t know if people think that’s a lot of time. just, I don’t know, but

⁓ That’s one of the main reasons why exchanges fail is because people don’t plan first. So ⁓ some of the top reasons why I see people fail, probably the number one is that people don’t know that they need to engage in accommodator or qualified intermediary before they close escrow on the property they’re selling. Again,

At least twice a month I have somebody call me and they say they want to exchange and I learned that they closed on their property and they took receipt of the proceeds.

As soon as you do that, you void your exchange. You cannot touch the proceeds from your sale period. Not a piece, not a portion. You cannot touch those funds. You want it at least a week. Before your schedule closing.

you need to engage a qualified intermediary, which includes, you know, filling out some paperwork, paying them their fee, which is usually about thousand dollars to $1,500, depending on the key lie. But it just amazes me even more so, a lot of these times when I hear about this, there’s an agent involved in the transaction, which means the agent did not advise their client to…

Kristen Knapp (11:47)

Hmm.

1031 Broker James (11:54)

Hey, we need to get you engaged with a QI before we close. Even if they decide after the fact they don’t want to exchange, at least you’re protected, which happens. A lot of times people, they’ll engage the QI and they’ll realize, you know, after close that, you know, an exchange really doesn’t make sense for me. Okay, well, at least now you know, right? You’re making an educated choice versus getting

A tax bill you weren’t expecting. The first person that anybody should talk to when they’re gonna sell their investment property is their CPA.

Kristen Knapp (12:34)

Yeah. And why is that the case? They just…

1031 Broker James (12:38)

a lot of people don’t know from capital gains tax people, they look at the ca you know, long term cap it taxes 20 % right now. But capital gains tax. on recapture. So you recapture. So if you’ve

depreciated that thing to the hilt. so whatever that aggregate sum of that depreciation, you get 25 % of that on top of the capital gains tax. So quick story. I networked with a lot of CPAs that call me and say, hey, you know, I’ve got a question or I’ve got somebody you should talk to. A couple of years ago, CPA called me and said, James, I’m going to refer you to David.

David is in escrow and is going to close. His closing is within a week. And he just found out for me that his capital gains tax is going to be more than $350,000 on the sale of his property. And he’s counting on this money to retire on. And apparently David

kind of lost his mind with the CBA because he was like, what? $350,000? No, I’m not writing a check for $350,000. And Scott told him, well, the only option you have is to do a 1031 exchange. So I was able to help David and get his exchange done. Had a very successful exchange and he’s very happy with his passive income that he has now, but he shouldn’t have been finding that out.

week before close.

Kristen Knapp (14:30)

Right. Yeah, I totally agree. And you have such great information on your YouTube and social media. And I know something that kind of sets you apart is you really, excuse me, you see it from the broker’s perspective as well, or the responsibility of a broker in the 1031 exchange. So could you let us know a little bit more about that as well?

1031 Broker James (14:52)

Sure.

I realized this is probably, I don’t know, three or four years ago when I really started doing a lot of presentation and speaking on the subject. And I would get in a room full of brokers and I would ask them, tell me what the three identification rules are of the 1031 exchange. And more times than not, nobody can tell me all three. You know, they’ll, they’ll

bring up the 45 day identification period or the 180 day timeline to close,

which those are rules of the exchange, but they’re not the identification rules. There are three identification rules. And part of the reason why they don’t know all three is because most people, probably 90 % of exchanges completed are using the main identification rule, which is the three property rule.

Kristen Knapp (16:16)

and

1031 Broker James (16:34)

And that is where you are allowed to identify up to three properties and the value of those don’t matter. So if you’re selling a $3 million investment property, you can identify, you know, because the first rule of the exchange is equal to or greater than. So you need to go find three, $3 million properties or

You can find three $1 million properties and buy all three. You can do that as well. But that’s the most common rule. It’s a three property rule. The other two rules are the 200 % rule and the 95 % exception rule. And nobody ever remembers the 95 exception, 95 % exception rule. That’s probably the, it is the least common.

Rule used because if you’re using that rule, then you’re probably. Exercising some extreme leverage, which nobody’s leveraging right now due to the cost of money. ⁓ But the 200 % rule could come into play, especially if somebody is considering exchanging into a DST portfolio that has multiple properties in it. So. Just the fact that that kind of knowledge and

Other things, another popular myth ⁓ is that, and even if you go online, if you go on TikTok and Instagram and look at some reels where agents talk about 1031 exchange or other investors talk about 1031 exchange, and they all talk about how you must reinvest the profit from the sale. That’s not correct. If you bought a property for

million dollars and now you’re selling it for three million, so it’s a million dollar profit, then people think that yeah, you have to reinvest that million dollars. No. The first rule is equal to or greater than the sale of the relinquished property. That’s the simplest rule because the other thing is debt confuses people. The debt must be replaced. So on that same three million dollar property, if there’s

$750,000 in debt. Obviously when you close that debt gets paid off. So now you’ve got 2.2 change with the accommodator. And a lot of people think, okay, that’s what I have to go buy. It’s another $2.2 million property. No, you have to go buy another $3 million property and go get another loan for $750,000 or replace that $750,000. You don’t have to have a loan. You can come out pocket.

Kristen Knapp (19:16)

Thank

1031 Broker James (19:29)

You can move money around within your investments. You can come up with that money in several different ways. But the point is, is that you must reinvest all proceeds from your sale and replacing the debt if there was that.

Kristen Knapp (19:48)

I can see that being a big reason that something doesn’t get approved. I can see that being a very common mistake.

1031 Broker James (19:52)

Mm hmm. Well,

and just to be clear, there are what’s known as a partial exchange. And so people will say, look, you know, in the case where it’s all cash, so that same three million dollar property, they own it, clean, clear. They will say, you know, we want to hold back five hundred thousand dollars to pay off some debt. You know, we want to pay off our house or pay off our credit card debt or whatever.

which they can do.

The problem is that if you know that you’ve got that full half a million dollars that you want to hold is to pay off a half a million dollars worth of whatever, that you’re not going to get $500,000 because the $500,000 is what’s known as boot, and you’re still going to be subject to the capital gains tax on that $500,000, which, regardless of where you’re at,

in the napkin is I basically say look you’re looking at 30 percent so if you hold back five hundred thousand dollars from your exchange which you can do but you’re going to pay 30 percent on that 500 so you’re going to still write a check for 150 thousand dollars the strategy around that is to go ahead and perform the exchange and then do a cash refi after you’ve bought your property

Sell for three million, go buy a $3 million property. And then I usually tell my clients, let’s wait about three months. There is no timeline. You can do it immediately. obviously whoever is going to provide that funding for you, whoever’s gonna do that loan, they’re gonna wanna see some paper trail of ownership. So you wanna collect rent for two, three months, let all the dust settle, tile everything, get updated properly.

So then you go and you say, okay, I want to take out a half a million or even a million dollars because a million dollar debt on a $3 million property, the debt service will be covered by the income from the property easily. Now you have that $500 or a million dollars tax free.

Kristen Knapp (22:12)

Wow. I’m learning a lot on this podcast. This is such great information and

1031 Broker James (22:16)

Thank

That’s

what I’m talking about. Those strategies, you won’t find those strategies online except on my YouTube channel. The strategies are not on my website. The website best1031online.com is really for information. I’ve got a glossary of terms on there. I’ve got a calculator on there. It’s really for people to get

Kristen Knapp (22:25)

Right, right.

1031 Broker James (22:45)

related to the 1031 exchange. And again, from a broker’s point of view, but my YouTube channel is really specific to here are some strategies. So one of the best QIs on the planet is IPX 1031. They’re probably the largest qualified intermediary in the country. They’re owned by Fidelity and

Really good friend of mine has been there for 25 years. His name is Greg Burns. And so if you go on my YouTube channel, you’ll see where we do episodes called the QI Corner. so Greg and I have very candid conversations about challenging exchanges that he’s done, that I’ve done, things that people don’t realize to talk about. so just ways to really ensure that your 1031 is a success. 1031.

Kristen Knapp (23:46)

I love that and where can people find this? what’s your YouTube handle? What’s your website?

1031 Broker James (23:52)

Yeah. So the website again is best1031online.com and the YouTube channel is also best1031online.

Kristen Knapp (24:00)

Love that. Everybody, please

go check that out. You can learn a lot. This has been awesome. Thank you so much for all this information. And I really urge everyone listening to visit your YouTube and learn more about this, because it sounds like you’re really helping people.

1031 Broker James (24:16)

That’s my goal. goal in October when I launched the channel, my goal was to cut the failure rate in half by 2030.

Kristen Knapp (24:25)

Yes, that’s a good goal. Okay, awesome. Well, thank you so much, James. Thank you for being here today. This has been amazing and we’ve all learned a lot from it.

1031 Broker James (24:35)

Well, I appreciate the opportunity, Kristen. Thank you very much.

Kristen Knapp (24:38)

Yes, thank you. Have a nice day and everyone subscribe if you love this podcast. Thank you so much.